There could hardly have been a more telling testimony of our national plight. Last week, China's premier, Wen Jiabao, and David Cameron announced £1.4bn of orders for British goods. A day later in Germany, Wen and Angela Merkel announced more than £10bnorders for Germany. We just don't produce enough goods and services that the Chinese – or anybody else – want to buy.

Germany is in the middle of a second "wirtschaftswunder" – economic miracle – with industrial production climbing by 15% over the last 12 months. By contrast, Britain's industrial production stutters along, growing at a mere 2.5%.

However, the high-level meeting between the prime minister, chancellor, deputy prime minister, governor of the Bank of England and chair of the Financial Services Authority at Number 10 on Friday morning was not about industry and growth. Instead, it was about dealing with Britain's monstrously oversized financial sector and, more particularly, about the choices it has made – how it lends and to whom.

Our banks, says last week's Financial Stability Review, have outstanding loans of £7 trillion, more than four times our GDP. But only 5% of that lending is to UK companies, the core, you might have thought, of a banking system's business. More than three times that amount has been lent in euros to borrowers in Europe, which, if the eurozone collapses amid widespread defaults by countries such as Greece, would provoke a second banking crisis, the subject of the meeting at Number 10.

British banks like to talk of their "risk appetite" and lending in ways that are "capital-lite", as Lloyds' strategic review, which came with a further 15,000 of job losses, did last week. This means they do not lend to high-growth, innovative British companies. That requires more capital and management, even if the wider economic benefits are huge. Instead, they prefer, as Lloyds graphically set out, to offer small- and medium-sized companies "capital-lite" but fee-intensive advice on "cash management, general insurance, pension and wealth management". Better to use scarce capital to lend, say, to Irish property companies or French banks who in turn lend to Greece.

For decades, governments have indulged these choices; to interfere would be to "politicise" banking. But it is profoundly political how banks use their capital and their judgments on what constitute risk. If, in extremis, they get their judgments wrong, the taxpayer has to bail them out, which is why governments must concern themselves in what banks do. Nor is it just a question of bank bailouts – one reason we have so little to sell to China is because of the choices our banks have made. Bluntly, they won't put enough of their precious capital behind British innovative enterprise.

Over the next few months, a rare chance for change is presenting itself. Tomorrow is the last day to make submissions to the Independent Commission on Banking, chaired by Sir John Vickers. Its job is to recommend reforms so the taxpayer never has to bail out banks again, but it is also charged not to damage the advantage Britain allegedly enjoys by having a gigantic City of London. If Britain is serious about trying to reproduce Germany's success, it would be seizing this opportunity to reform finance, hardly a new complaint. Committees and commissions have identified the same problem for close to a century.

The Vickers commission could yet be a tremulous start. In its interim report, it balked at some of the braver and more radical ideas – breaking up our banks that have become too big to fail or separating out the high-risk, investment banking arms that are cross-subsidised by the rest of the bank. Instead, it came up with a much milder idea. It proposes "ringfencing" different parts of banks' operations while requiring them to hold more capital. The bigger the buffer, the safer the bank.

Vickers hopes this might make safer the parts of the banking system which are important to the economy. But in a submission that the Work Foundation, supported by National Endowment for Science, Technology and the Arts, is preparing for the banking commission, Paul Nightingale and myself argue that it could also transform the risks and rewards from lending to high-growth small- and medium-sized companies.

In the current regime in which a bank has a multiple of choices, naturally it will use its scarce capital to get the maximum return – and that will not be supporting innovative companies when there are lush rewards in the exotic demimonde of shadow banking. A bank such as RBS under the domineering leadership of Fred Goodwin would overtly use the capital and deposits in its bread-and-butter high-street business – implicitly guaranteed by the taxpayer – to make massive punts trading all kinds of rubbish.

But once that business option is denied it by a ringfence (better still a formal separation, but that is not on the table), suddenly lending to small- and medium-sized companies has to compete, not with the high-risk profits from investment banking, but with more humdrum forms of lending with their associated lower returns. It becomes more attractive to invest time and effort to develop a banking business that supports wealth-generating companies – rather like the Co-operative and the Swedish Handelsbanken, now expanding at huge speed in Britain. Equally, investment banking becomes exposed for what it is: a high-risk business dependent upon cross-subsidy from the rest of the bank and taxpayers to generate otherwise impossibly high returns and their associated bonuses. It will require more capital still.

It should be no surprise that Vickers and his team are under enormous pressure to make their proposed ringfence as porous and soft as possible. Last week, Andrew Tyrie, chair of the Treasury committee, expressed his concern that the banks were doing deals and lobbying behind closed doors. He wants everything out in the open.

Vickers holds two formidable aces. The first is that the chancellor has publicly backed the idea of a ringfence, so for him to propose anything weaker than Vickers is a political impossibility. The second is that the banks themselves are divided over the proposition. HSBC endorses the idea, as will the Co-operative and probably Santander. Lloyds would accept it as the price for having to sell off less of its branch network.Implacably opposed are RBS and Barclays, for whom a tough ringfence represents an existential challenge to their business model. Barclays is doubtless telling the government it might move to New York, RBS that a ringfence threatens its capacity to return to profitability and thus successfully recouping the government's stake.

For the UK, the choice is no less existential. Tough ringfencing and more capital are not magic bullets that alone solve the problem, but they are preconditions for a better banking system. So what is it to be? Investment banker bonuses or the foundations of a more enterprising Britain? A lot hangs on the next few months.